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Saturday, December 29, 2012

Performance and VaR Together

A lot of market risk analysts often question how they can compare risk with return or the relevance of tracking error in the context of Value at Risk and performance reporting together.

In this short blog posting, I link to a presentation which explains how performance reporting, risk measurement and tracking error may be delivered side-by-side.

Applied Value at Risk

The presentation can be downloaded from the following [LINK]The market risk framework described in the presentation link aboveconsists of several phases of system development. All of these phased risk initiatives need to be enabled before a risk analyst would be able to sufficiently report risk, integrated with performance.The five phases of maturity have been listed below and have unique purposes.

Each phase of development requires previous elements to be complete and operable before a subsequent aspect of the risk framework can be activated. Leaping from Phase 1 to Phase 5 directly, would turnout less mileage in the risk reports and would probably mislead traders in some respects. This is especially case when these front office people are driven by tracking error charts more so than detached Value at Risk numbers in tables.I believe that one of the reasons why Value at Risk often fails at the point of implementation, is that risk reporting is constrained in silos. The investment managers are driving returns, while risk teams attempt to plug control. These two aspects of the same process need to be connected, showing a portfolio from both the risk and return point of view together.

Author

Martin Davies is a risk framework architect with strong domain knowledge across a diverse set of risk fraternities, a background in banking front-to-back and the ability to articulate business requirements into functional information technology concepts. He is focused on structured products for emerging markets and works with several tier one banks, regulators and brokerages across South East Asia.